Latest Developments in Dealing With "Tough Legacy" IBOR Transition Contracts

United Kingdom

On June 23, 2020, the UK Government announced that it intends to bring forward legislation to amend the UK Benchmark Regulation to give the Financial Conduct Authority ("FCA") enhanced powers in connection with the orderly wind-down of critical benchmarks such as the London Interbank Offered Rate ("LIBOR"). The new legislation is expected to give the FCA tools to address the problem of "tough legacy" contracts, which contain no appropriate fallback mechanism and/or have no realistic possibility of being renegotiated or amended.

The UK Government announcement expressly states that it is bringing forward the new legislation instead of measures to directly impose legal changes on LIBOR-referencing contracts that are governed by English law.

The UK Government's proposal is to give the FCA the power to direct the administrator of LIBOR to change the methodology used to compile the benchmark, if the FCA finds that the benchmark is not representative of the market it seeks to measure and that such representativeness will not be restored.

The FCA recognized in its response to the announcement that this would not make the benchmark representative again. Instead, the aim is to allow the FCA to stabilize certain LIBOR rates during a wind-down period so that its limited use in legacy contracts could continue. The FCA has emphasized the limited nature of this solution—any "synthetic LIBOR" will not be available for new contracts nor for any existing contracts, other than those where the FCA "considers this appropriate."

The FCA has stated that it will publish statements of policy on its approach to the potential use of these powers, but has already indicated that it is likely to involve establishing an accepted way of calculating an additional fixed credit spread that reflects the expected difference between LIBOR and risk-free interest rates.

Europe

In a parallel development, it appears that the European Commission wishes to speed up the amendment to the EU Benchmark Regulation ahead of BREXIT. In response, the High Legal Committee of the Paris Marketplace ("HCJP") which has been working on and publishing a series of reports on the Interbank Lending Rate ("IBOR") transition, is due to hold an urgent meeting to structure the French answer to the Commission's new favored approach to deal with "tough legacy" contracts. The plan seems to be to allow the European Securities and Markets Authority to impose a change in methodology when an index becomes unrepresentative or is doomed to disappear.

The impact of these proposed changes on IBOR transition efforts outside the United Kingdom (and European Union) remains uncertain. However, the developments are likely to increase attention on possible legislative solutions in other countries, including the United States (where the Alternative Reference Rates Committee has already set out its proposal). While the clear focus of legislators and regulators remains on encouraging active transition by market participants, these developments show that attention is also turning to the potential consequences of LIBOR cessation for those contracts where any transition remains challenging.